William Gale’s Argument Against the FairTax
Below is William Gale’s argument against the FairTax, which appeared in the June 2005 issue of Costco Connection. I will post the “for” argument by Rep. Linder tomorrow, if I get a chance [update: view here].
For more background on this Costco poll, see my earlier post “56% of Costco Members Favor Retail Sales Tax.”
I am inserting numbers in brackets before each of his assertions and/or arguments, so that anyone who wishes may rebut his specific points in the comments.
From the byline: “William Gale is the Arjay and Frances Fearing Miller Chair in Federal Economic Policy at the Brookings Institution and co-director of the Tax Policy Center.”
The notion that a national retail sales tax could effectively replace the entire federal tax system is a pleasant diversion. But careful research has shown that it is a dangerous and ludicrous fantasy.
[1]The 23 percent rate that Rep. John Linder says would be needed is really a 30 percent markup at the cash register. To be clear, under his proposal, if a good costs $100 before the sales tax is imposed, it would cost $130 (not $123) including the sales tax. Most people would call this a 30 percent sales tax.
[2]Academic research shows that the calculations that lead Rep. Linder to this 30 percent rate contain a big mathematical mistake. As a result, using his tax rate would raise the federal deficit by $6 trillion over the next 10 years! Avoiding this would require a 42 percent sales tax or markup.
[3]Rep Linder’s tax rate also assumes there would be no tax avoidance or evasion, even though most serious analysts think the underground economy would thrive under the sales tax. Allowing for just half as much evasion as exists under the income tax would raise the required sales tax rate to above 50 percent.
[4]It seems doubtful that people would tolerate a tax at that rate on necessities such as food, health, house purchases and mortgage payments. (Yes, Rep. Linder’s tax would tax a good chunk of mortgage interest.) [5]The number of people without health insurance, for example, would likely rise by more than 10 million. But if we exempt any of these items, the required rate would have to rise.
[6]The required rate would be even higher if Rep. Linder’s tax were not allowed to impose massive burdens on state and local governments. “Paying” for the federal government by taxing state governments does not reduce tax burdens, it just shifts them. [7]So expect state and local taxes to rise.
[8]Countries that have tried to enforce retail sales taxes at rates above 10 percent have uniformly given up because of evasion. Likewise, no state sales tax has rates that high. If we did impose a 50 percent or higher sales tax, it would be evaded massively.
The tax system’s many problems require serious thinking and creative solutions. But a national retail sales tax is not the answer.
So there it is. Have at it, folks. (Remember to be polite and factual.)
I know answers to some of these objections, but not all of them. (E.g., I’m not up on the history of sales taxes in other countries.) I look forward to reading the comments on this post.
[1] The 23% in the FairTax proposal is stated as an inclusive rate, the same as the income tax rates. Most sales taxes, such as state sales taxes are stated as exclusive rates. If you make $100 and pay $23 in income tax that is 23%. If you pay $100 for an item and $23 dollars of the $100 goes to the proposed sales tax leaving $77 as the cost of the item, that is 23% (23 / 100 = 23%). But the way William Gale wants to present it is if you pay $77 for an item then add $23 at the cash register its 30% and he is correct but it’s the same amount of dollars just different figuring (23 / 77 = 30%).
Read more about this at FAQ #47 on http://fairtax.org/ and 47 more great questions on the FairTax
[2] As I understand the FairTax proposal it is not aimed at increasing or decreasing the amount of taxes collected. It is a way of making taxation much simpler and more visible (we actually see the total amount of taxes we pay). William says the 23% will come far short of raising enough revenue. I don’t go along with this but for arguments sake let’s run with it. The FairTax is proposed to be a revenue neutral replacement for the present tax system . So if 23% won’t cover it then how much are we really paying now. Let’s see. With the complicated income tax and its table of rates its hard to place a figure but let’s say 15% for income tax (probably higher for many people). Then FICA takes 12.4% and Medicare 2.9%.
Corporations are taxed day in and day out and they have to add that to the cost of doing business. They also have tremendous costs figuring out how much taxes they have to pay and figuring ways to not pay those taxes and paying lobbyist to help them get out of more taxes. All these costs are also added in to the cost of doing business. It is estimated by more educated folks than I that all these corporate taxation costs add 22 to 25% to the cost of goods and services we purchase. Lets say we spend 50% of our income (I’m sure it is much more but this make easy figures) which means we are paying at least 11% (inclusive again) of our income to imbedded (hidden) taxes in what we buy.
Let’s total this thing: (These are my numbers but they seem to make cents to me.)
15% Income tax
12.4% FICA
2.9% Medicare
11% Hidden taxes (probably more)
41% TOTAL TAXES PAID TODAY
So if Rep. Linder is correct we are going to get a bargain. If he is not we got a long way to go before its not a bargain.
You may ask how can it possibly be a saving of 18%. Well, if you read the FairTax Book you find out that for every $3 of tax collected there is $1 dollar spent on tax compliance (think that comes to 25% inclusive or 33% exclusive) you may start seeing where the savings is coming form. There is much more good info in the book and at http://fairtax.org/ to help anyone understand the advantages of this simple and FairTax.
FAQ #’s 5 and 6 on http://fairtax.org/ speak to this question also. The FAQ;s on this website cover all questions I have heard anyone raise about the FairTax.
The FairTax is a good thing. It will make April the 15th just another glorious day is the USA.
In response to; “One Response to “William Gale’s Argument Against the FairTax”” you use the example that if you pay $100 for something the tue cost is $77 but that is not the example that Willian Gale used, He said if it costs $100 then ou must pay an additional $23 in tax, which is correct; Gale also talks a bout skued math and yor reply uses skued math so in trying to rebut you only strengthend his argument.
No matter how you crunch the numbers, the Fair Tax is revenue neutral. The same dollars will be collected as with the income tax. With the Fair Tax we just have a better handle on the cost of government. No more smoke and mirrors as with our current system. The best part is that all those who avoid paying their fair share of income tax because of loopholes, and cheating will have a tougher time doing so with the Fair Tax. Yes, there will be cheaters, but it will take two to tango. Plus, more people will be contributing to the total amount of tax collected. Do criminals, illegal aliens, or tourists currently contribute? I don’t think so. By eliminating corporate taxes American companies will be more competitive thus creating more jobs thus more spending.
Do you realize we are already paying a consumption tax in addition to our income taxes? The current consumption tax is the embedded taxes and compliance costs that are passed on to us each time we pay for a product or service. I would much rather pay a 23%, or as some people say, 30% consumption tax rather than a 15% income tax plus 15.3% for S.S. and Medicare, plus 22% for imbedded taxes and compliance costs. Even without a prebate, the Fair Tax is a better deal.
The poor really make out with the Fair Tax plan. If they are earning the poverty level or less, they pay no tax. With our current system, even if they have no income tax liability, S.S. taxes and Medicare are deducted from their paychecks, plus they pay imbedded taxes and compliance cost when they make a purchase.
Mr. Gale also makes this statement “The number of people without health insurance, for example, would likely rise by more than 10 million. But if we exempt any of these items, the required rate would have to rise.” This is ridiculous! If anything more people will have health insurance. I am in the health insurance business. The imbedded taxes and compliance cost in insurance premiums is huge. You may even see health insurance premiums come down. Plus, many companies who currently are unable to afford health coverage because of corporate tax burdens will now be able to cover their employees.
Other than tax lobbyist and criminals, I can’t see how anyone can be against the Fair Tax.
William Gale does not take into consideration that imbedded in that original $100 cost of a product is the cost of tax compliance i.e. tax attorney, accountant, bookeeping cost associated with paying taxes not to mention passing the cost of the taxes paid on to the consumer in the price structure of the item. With the removal of these hidden costs it reduces the cost of the item by about 22 percent and when you add back in the 23 percent national sales tax it increases the final cost by about 1 percent at best. Pretty much a “wash” or revenue neutral.
i’m not anti-fair tax, i’m happy the discussion is progressing (whether it ends up being fair tax or something else, i think there’s got to be a better way), but i think you’re assuming a lot if you think the ‘hidden costs’ will be stripped out. many/most businesses will just tack on the 30% and hold their hands up, “what can i do? it’s a federal tax...” as always, what is paid defines what it’s worth, what is charged is what it costs.
Enjoy your ability to criticizen/question the FairTax while you can...because it’s about to be taken away...
The Americans For Fair Taxation (fairtax.org) are on a mission to squash out any public criticism of the FairTax plan and are attempting to exploit the federal trademark system for the ADMITTED purpose of being able to shut down anti-FairTax websites during the upcoming elections. They have an open application to obtain a service mark for the word “FairTax.” Genie Hayes, the communications director for AFFT, openly admitted that the goal of AFFT is to get this service mark and be able to yank any anti-FairTax websites as well as to have total control over any shirts, bumper stickers, or anything of that nature that is printed with the word FairTax. They are attempting to get the strong arm of the federal government to back them up in hindering free speech and open/honest debate.
The FairTax is promising to become a rather prominent issue in the upcoming Congressional elections–and if AFFT succeeds in obtaining this service mark, they are going to be in an excellent position to keep people from criticizing the FairTax Act.
The time for opposition to their application is fast approaching. I know that an application for a service mark can’t be opposed just because the applicant’s motive is unethical. However, I do believe that there is a very STRONG case that AFFT doesn’t meet the legal requirements for obtaining a service mark.
Unfortunately, as it stands right now, I think they’ll win their service mark and they’ll be on the road to having the power to tell people that they cannot participate in public debate regarding H.R. 25. Perhaps, at least, the public will be informed of this attempt to filter open and honest critiques.
MoMospy
Sorry to be the one to have to inform you.
All a service mark does is prevent another organization or person from claiming the use the same title in connection with another organization or document.
It certainly does not prevent its use as a reference in discussion or debate of any kind.
Suggest you find something real to get upset about, this one isn’t it.
jd, please read the FairTax book and the FAQs and research at www.fairtax.org. Then read the FairTax book again.
[...] “Countries that have tried to enforce retail sales taxes at rates above 10 percent have uniformly given up because of evasion.“ Source: William Gale’s Argument Against the FairTax [...]
“Countries that have tried to enforce retail sales taxes at rates above 10 percent have uniformly given up because of evasion.“ Source: William Gale’s Argument Against the FairTax [...]
This is a specious argument. He cites no examples. I posit that those countries (if any) were trying to add a high retail sales tax on top of income, vat and other taxes. Let us know what countries and what circunstances. This guy sounds like the employee of a tax service.
I don’t think we’ve really discussed the “underground economy” that Mr. Gale says would thrive. As far as I understand it, as used goods are not taxed, this could create a problem with many people selling “used” goods the way they do at flea markets and such. Any thoughts?
Jessica - Elsewhere I have written that the fear of a huge underground economy is misplaced. There will be some evasion and avoidance. Today there is a huge problem with evasion (illegal) and avoidance (legal) of taxes.
84% of retail sales are made by large retailers. It will be very difficult and very dangerous to their business interests to evade the consumption tax. How would a Walmart instruct it’s employees to evade the tax? How would the employee benefit from scaming the system? How long before the scam would be uncovered? How would a Walmart operate without a business license?
Flea markets have relatively small volume. How would they acquire products to sell? Theft? Self made? Smuggled from another country? If purchased legally they would need a business certificate to be exempt from paying the tax when purchased. Registration makes the transactions traceable. Audits can and will identify scams of material amount. These people will be fined and possibly incarcerated for tax evasion. The tax loss will be small. I doubt these transactions show up in consumption statistics today and thus are not included in the calculated Fair Tax base.
Remember prices are going to fall when corporate payroll and income taxes along with compliance costs are eliminated. Competition is going to force business to reduce their prices. Walmart pays $10 for an item today. Walmart knows that the supplier has received a 10% or more reduction in his costs. If Walmart doesn’t get the product for $9, they are going to find another supplier. Now Walmart can sell the product for 10 percent less. Are Target, Kroger and other competitors going to let Walmart have a huge price advantage?
Initially product prices including the Fair Tax will increase by 17% based on a Fair Tax rate of 23% inclusive. Over time prices will probably fall even more as wages are either reduced or do not grow. Competition will again force salaries and wages to be realigned to the current balance. Remember under the Fair Tax, initial NET salaries and wages will jump by 7.65% (9% tax exclusive) for the payroll tax elimination and another estimated 10% (tax exclusive) on average for elimination of income and estate taxes.
As an auditor/accountant by trade, I believe that evasion/ and avoidance under the Fair Tax will be much less than today and will be easier to audit. There is no way that Fair Tax rates are going to reach anywhere near the levels that Gale and others guess they will. If congress chooses to take a larger percentage of GDP in taxes, the Fair Tax rate will increase. That is a problem with excess government spending not with the Fair Tax.
For those who are interested in being informed, here’s a link to the Presidential Advisory Panel who looked into this concept in 2005 amongst other tax reform options. Here’s the main page.
http://www.taxreformpanel.gov/final-report/
Here’s Chapter 9 that deals with the “Fairtax”
http://www.taxreformpanel.gov/final-report/TaxReform_Ch9.pdf
Under a Fair Tax system, evasion will be massive. Just because “84%”, wherever you got that number, of retail sales are made by large retailers, what makes you think that number will stay the same if a national sales tax is enacted? It won’t. Smaller businesses need to provide incentives to consumers who purchase from large retailers. What better way to get people in the door if the consumer doesn’t pay sales tax? Or maybe pay only a portion? These businesses will become the underground market and people will want to shop at these business, because, in reality, people don’t like paying taxes and will do things to avoid them. Sales tax evasion runs rampant in all states which have them, and these are states that only have a 6-9% sales tax. Imagine what happens when you have a sales tax of 30%! Studies have already shown any sales tax over 10% will be subject to massive evasion. And since the IRS is abolished under the Fair Tax plan, who is to stop these businesses from doing this? Who is going to make sure businesses are reporting the correct amount of sales and sales tax? Quite a loophole there. Once you ask yourself this question, you will realize the “IRS” is going nowhere, but it will take on another form. Some independent agency with authority must exist to ensure proper collections. Without a collection agency, business owners can manipulate their records to no end since no one is looking after them. Do you think the government is going to allow business owners be the final collector of tax? Never. Ever. Maybe the IRS will be gone, but a new collection agnecy will have to exist, which will be the theoretically same as the IRS. Except they won’t audit your income, they will audit your personal belongings and demand receipts for everything that you have. Yea, fun.
This is where you say the Fair Tax and abolishing the IRS is a scam. Abolishing the IRS will never happen, its a joke and anyone who thinks it can happen is living in a dreamworld.
This proposal hurts the lower-middle class more than anyone. The idea that people in this bracket can get away with spending only 50% of their income is laughable. In reality, this hurts consumption based markets, and largely benefits the wealthy, who spend far less of their income in consumption, and gain most of their income from capital markets. This is yet another veiled attempt from the rich to lower their tax burden.
Let us also not forget that a federal consumption tax would be illegal, as enumerated in Article 1 Section 9 of the Constitution: “No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herin before directed to be taken.” The federal income tax is only legitimate because of the 16th amendment, which specifically authorizes it.
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